Worst bond rout since sovereign debt crisis sees companies rush to Securing financing Ahead of a potential capital drought. A hit to stocks worth about $200 billion.
French President Emmanuel Macron’s decision earlier this month to confront the gains of the far right across Europe Quick poll At home he has Inverted Markets across the region, leading to a sharp re-pricing that saw billions of euros flow out.
On Sunday, investors will find out if there is room for the selling to continue.
The stakes are high. France’s fiscal integrity has been called into question as investors shorted state bonds even before Macron’s surprise decision, and the region’s appeal as a stable and relatively volatility-free alternative to US markets has taken a hit.
David Zahn, head of European fixed income at Franklin Templeton, summed it up this way: The spread between the French bond yield and the German bond yield could “easily” fall below 100 basis points from around 80 basis points now – which has been Something unimaginable less than a month ago.
“There is nothing to win in this market,” said Stephane Dieu, a senior portfolio manager at Eleva Capital SAS, who has reduced all of his fund’s exposure to France.
Traders are heading into the weekend’s parliamentary election holding the most French bond futures contracts in at least a year, a sign they are betting that yields will rise. Stock pickers are hedging losses by linking the most-traded options to Europe’s main index in two years. Currency traders are buying derivatives that protect against the euro’s fastest decline in 15 months.
The main fear for markets of all stripes is that the new French government will push the country deeper into debt. France’s deficit is already well above what is allowed under EU rules, and a strong performance from either the right or the left would be seen as increasing the chances of the government easing fiscal constraints further.
Standard & Poor’s global ratings Its level has been reduced Country’s credit score at the end of May and the IMF pridect Its deficit will remain well above the 3% limit set by the European Union for years to come.
The pain for bonds could translate into pain for banks if they end up having to swoop in and buy up notes if foreigners head for the exits. With French lenders already causing losses among euro zone banks in June, the contagion could at that point spread beyond France’s borders, which could lead to higher borrowing costs in weaker EU member states.
Memories of the region’s debt crisis are still on investors’ minds MindsThe effects from France could once again call into question the entire euro project, a portfolio manager at Allianz Global Investors said recently.
The last time Le Pen’s far-right party came close to seizing power was in the 2017 presidential election, where he promised voters a referendum on whether the country should withdraw from the euro. Although she has since softened her stance, her party’s policies have made investors wary.
The risks of a “French exit”
A measure of credit default swaps (CDS) that indicates a possible French exit from the European Union has almost doubled since the European elections, reaching nearly its highest level since 2017.
“The issue boils down to whether people want to go down the path of thinking about revaluing the currency,” said Eric Weissman, portfolio manager and chief economist at MFS Investment Management. “I think that will not be justified regardless of the outcome. But the market may have Other ideas.”
The political unrest in France has already cast a shadow over the wider region.
The weakness in French sovereign bonds has spread to Italy, the poster child for Europe’s financial profligacy. There, the spread to Germany has reached its highest level since February.
In credit markets, the risk premium that French companies pay to borrow compared to their eurozone peers has jumped to its highest level since the run-up to the 2017 election. Before the early vote was called, this cost had been consistently lower.
Trading in derivatives markets, which pay out if eurozone bank shares fall, reached their highest levels since 2016.
Banks are seen as vulnerable to concerns about a country’s political future through their holdings of government debt and exposure to poor economic decisions. While sovereign bonds made up just 2.4% of French banks’ total assets as of the first quarter, that figure could rise if lenders step in to buy as foreign investors flee.
“existential issue”
“Market access is an existential issue for banks,” said Gordon Shannon, portfolio manager at Twentyfour Asset Management. “Periods of market stress limit the ability to raise new capital.”
To be sure, the volatility caused by the election could dissipate quickly, and investors expect that Le Pen’s party – if it wins the most seats – will tread carefully to boost its chances in the 2027 presidential election. France’s benchmark CAC 40 stock index has performed well after most of the election legislation in the past thirty years.
Polls suggest no party is likely to win an absolute majority after the vote, and former French President Francois Hollande indicated this week that he would be willing to build a government. New coalition To rule if the elections result in a hung parliament.
Karen Ward, chief market strategist for Europe, the Middle East and Africa at JPMorgan Asset Management, sees weakness in French banks as a buying opportunity. The next French government will be aware of the chaos caused by the unfunded tax cuts proposed by UK Prime Minister Liz Truss in 2022.
“In two months we won’t be talking about French politics at all,” she said. “We’re not in 2011-12, and none of these most populous parties are in favour of leaving the euro. It’s about immigration, a theme we see in politics across the West.”
Yet the sense of anxiety is palpable. The sharp rise in political risk has prompted many portfolio managers to abandon the practice of buying European bonds in anticipation of catching up with U.S. debt ratings.
This is in line with the shift in stock market sentiment, as uncertainty ahead of Sunday’s vote has derailed Europe’s bullish case, prompting investors to reduce their exposure and rebalance their positions towards U.S. assets.
Interest rate traders expect the country’s borrowing costs to remain high for the foreseeable future.
“The French spread will not return to its pre-election level anytime soon,” said Sonia Renault, interest rate strategist at ABN Amro. “The question is how quickly they can withdraw and whether the bond market or institutions need to force them to do so.”